February 1, 2023
*This is the next article in our 2023 Southwest Economic Outlook series. Hear from Oklahoma State University and OSU Extension Service, and Texas A&M University and TAMU AgriLife Extension Service economists about the 2023 outlook.
If you have sold more livestock than normal this year due to the drought or other weather-related conditions, there are two income tax provisions that may provide some tax relief. Many counties in the western part of the United States have received federal disaster declarations from the Secretary of Agriculture. The federal disaster declaration allows livestock producers the opportunity to use income tax provisions that allow a producer to reduce the income tax consequences of bunching income from the sale of livestock in excess of normal annual sales if certain conditions are met. For a more detailed discussion of the rules, tax consequences, reporting requirements, and examples, the publication titled: “Weather-Related Sale of Livestock,” is available on the Rural Tax Education website, http://www.ruraltax.org; under the “Tax Topics” link.
The first provision applies to a producer who has sold more livestock than normal due to adverse weather. The income from the animals sold in excess of normal sales may be postponed until the following tax year when the income would have normally been recognized. However certain conditions must be met. The weather-related condition must have caused the area to receive a “federal disaster declaration.” Refer to the following map which shows U.S. counties that received a drought designation from the Secretary of Agriculture. Livestock producers in those counties can use this provision if they meet the following qualifications. The producer's principal business must be farming and use the cash method of accounting. The producer must show that the livestock would normally have been sold in the following year. The weather-related conditions that caused an area to be declared a disaster area must have caused the sale of livestock. This provision applies to any livestock sold in excess of normal due to weather-related conditions. [Refer to IRS Code Section 451(g)].
The second provision only applies to breeding, dairy, or draft animals that were sold in excess of normal. For the animals sold in excess of normal, a producer may elect to replace the animals sold, within a two-year period after the year of sale with like animals (used for the same purpose) and thus defer the recognition of income until the new animals are sold. Unlike the first provision, there is no need for a disaster declaration; all that is needed is proof that drought conditions existed which caused the sale of additional animals. However, if an area has received a federal disaster declaration (as shown in the included map) made by the Secretary of Agriculture, the replacement period is extended to four years instead of two.
An example of how the rules for electing to replace the animals sold follows. A beef producer sells $20,000 of breeding cows in excess of normal culling due to drought conditions. An election is made on the tax return to postpone the gain and purchase replacement animals. The producer must then replace the cows within the required replacement period. If the excess animals were sold for $20,000, the producer will need to purchase $20,000 of replacement animals to completely defer the gain from the sale. A producer must repurchase the same dollar amount of animals which were sold in excess of normal, not the number of excess animals sold. If only $18,000 is spent on the replacement animals, then $2,000 must be recaptured on an amended tax return and the tax paid. If more than $20,000 is spent, the excess amount is taken as depreciation expense. There is no requirement as to how long the animals were held by the taxpayer in order to receive this treatment, but the producer must provide evidence of the weather condition and a calculation of the gain for each number and kind of animal sold. [Refer to IRS Code Section 1033(e)]
A producer must evaluate the following points to determine whether it will be beneficial to postpone gain recognition by replacing the animals or electing the one-year deferral. The estimated amount of expenses for the following tax year, potential income tax and capital gain rates for future tax years, net operating loss carry forward amounts, the ability to use income averaging, or other tax items the producer may have. It is important to do some extensive tax planning to make a sound economic decision concerning the two elections. The potential increase in future rates will have a definite impact on the decision.
This is only a brief discussion of the rules that apply to weather-related livestock sales. Please consult your tax preparer or advisor for additional information concerning the income tax implications that would apply to your specific business situation.
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